From ZIRP to NIRP in the blink of an eye. Last year, the global markets were on tenterhooks on speculation as to when the US Federal Reserve would discontinue its zero interest rate policy.
That was duly done in December, when the Fed’s zero interest rate policy ended and 25 basis points were added to the Fed Funds rate. Now, we are in the land of NIRP – that’s negative interest rate policy, for all you acronym fanciers – and it may be coming to a central bank near you sooner than you think.
Many have been at it for some time. Sweden, Denmark and the eurozone have been running negative interest policies over the past few years, but no one really noticed until the end of January, when the Bank of Japan jumped on the NIRP bandwagon.
Still, the thing that really brought NIRP into the spotlight was an extraordinary statement from Fed chair Janet Yellen to the House Financial Services Committee the week before last.
In her testimony to Capitol Hill, Ms Yellen suggested that NIRP could become the official Fed modus operandi.
Really? You put interest rates up in December, in the process unleashing a global market maelstrom and committing what is now widely regarded as one of the biggest policy mistakes of the modern era, and, while the ink is barely dry on that decision, you then suggest that negative interest rates might instead be needed for the US economy?
It brought to mind identical twins Tweedledum and Tweedledee, Lewis Carroll’s wonderful creations from Through the Looking Glass.
Let me remind you how the portly pair respond to Alice, the heroine of that classic British children’s book, when she wonders if their motionless state might mean they are waxworks (that surely applies to a few of the world’s central bankers, past and present):
“I know what you’re thinking about,” said Tweedledum; “but it isn’t so, nohow.”
“Contrariwise,” continued Tweedledee, “if it was so, it might be; and if it were so, it would be; but as it isn’t, it ain’t. That’s logic.”
THAT COMIC DESCRIPTION might well apply to the new Fed logic, too. As I read the diatribe against the Fed for decades of “very poor” communications from Neel Kashkari, the newly installed head of the Minneapolis Federal Reserve, I wondered if Ms Yellen’s recent communication had not come straight from the pages of Lewis Carroll.
If opening the door to NIRP so soon after abolishing ZIRP represents the clarity and openness Mr Kashkari is calling for at the Fed, then give me the obfuscation of Alan Greenspan any time.
I wonder how many basis points of risk mitigation Mr Greenspan’s gnomic presence at the Fed helm was worth to the average investor, in contrast to the countless basis points of risk added to the global financial markets in Ms Yellen’s as yet short tenure.
To return to NIRP: negative yields took hold in the Japanese government bond market a few weeks ago, and I doubt that the players who matter could really care less.
Holders of JGBs, who have owned them from years back, will have long ago ceased using the outstanding coupon rate on those bonds to discount their future cashflows and will instead have been using the prevailing near zero short-term interest rate to determine the net present value of their debt holdings.
The recent move to negative yields will indeed have produced a rather handy capital appreciation for these long-term holders of that debt who have owned it since yields were positive.
In the meantime, if you’re a bond trader looking to flip a turn from JGBs, the new negative yield regime will suit you as bond prices appreciate. The only ones to lose out are buyers entering the JGB market at the prevailing negative yields and hold the bonds until maturity.
IT’S THIS GROUP that is now in focus: the long-term liability matchers in Japan, such as the life insurance and pension funds that seek to lock bonds away until maturity to meet obligations on life policies and pension annuities.
But have they ever done that anyway? My own experience as an institutional bond salesman at a big Japanese bank long ago tells me that the reality is something very different.
Japan’s long-term institutional buyers have always dipped in and out of the market, trading the curve and switching from liquid debt to off-the-run issues for a turn inside one or two standard deviations, and were more than willing to go into cash should the prevailing market circumstances warrant it.
Meanwhile, to hell with negative short-term rates and their supposed erosion of banks’ lending margins. Banks can always lend the usual way: by borrowing at Libor in the interbank market and charging a spread over that to their clients. Nothing to panic about there.
I have no worry about negative interest rates at the short end – and certainly not at the long end, where a massive rally is kicking off that promises capital apprecation at long durations to rival the equity markets. The biggest worry would be a drying up of the interbank money market. For now at least, there is no sign of that happening.